In the defence of small-cap resource stocks

IN THE past two months, the oil price has climbed about 22 per cent going from $US77 ($A73) a barrel to its current level of $US94. Meanwhile, over the past six months, oil and gas producers, both big and small, have gone either sideways or have been heavily sold down.

IN THE past two months, the oil price has climbed about 22 per cent going from $US77 ($A73) a barrel to its current level of $US94. Meanwhile, over the past six months, oil and gas producers, both big and small, have gone either sideways or have been heavily sold down.

Which will correct, the oil and gas stocks, or the oil price?

Will there be a massive capitulation of the global oil markets because they realise that investors in companies such as Beach Energy, Drillsearch Energy, Sundance Energy and Molopo Energy have been right in selling their stock?

Radar thinks a more likely answer is that some of these companies have been sold off too aggressively.

The market for small-cap resource stocks has staged a mini fightback this month, but in the past three months, the ASX Small Resources Index is still down about 17 per cent.

A big reason for the market's fear is uncertainty over funding, since mining is a very capital-intensive business.

Sentiment could also be damaged in the oil and gas sector by the revolution in shale gas and the dark art of fracking. Because of the massive supply that has come on stream, the gas price in the US has plummeted in the past two years from $US13 per mmscf (million standard cubic feet) to levels close to $US2.

So far there is limited substitution of oil for gas in the US, but equity markets look forward and this might change as transport fleets are converted to run on liquefied natural gas (LNG).

One company in the middle of all this, and which Radar has mentioned before, is Sundance Energy (SEA), whose shares, at 43?, have almost halved in the past five or so months. Sundance has about 50 producing wells located in what analysts describe as the "hot spot for shale oil and gas production" the Bakken region, primarily in North Dakota. The US Geological Survey estimates the region contains 3.65 billion barrels of oil.

The selloff appears to be unjustified, first because oil, rather than gas is the key for Sundance.

About 75 per cent of the company's production is in the black stuff, while the remaining 25 per cent is gas that is "liquids rich", according to analysts, enabling Sundance to get a better price for it.

Will Sundance need to raise capital?

The main reason for its share price demise is that the market thinks the stock will need to raise equity funds.

A quick look at Sundance's financial statements shows it is running precariously close to the wind, with an operating cash flow of less than $10 million for this year, and capital expenditure and exploration in the region of $35 million. It is also due to spend about $75 million this year.

But Bell Potter's oil and gas man, Johan Hedstrom, says it is probable the company won't need to raise cash, partly because of its $100 million debt facility. The company can draw down $25 million of it at this point, but this is based on its oil and gas reserves at June 30 last year.

It is undergoing a review of those reserves, which should more than double, meaning increased cash flow and Sundance will be able to draw down more funds.

The main reason for Mr Hedstrom's confidence is the sale of one of Sundance's Bakken assets for between $150 million and $200 million. This could go ahead as early as September.

According to Mr Hedstrom's forecasts, the stock is trading on a PE of four times for fiscal 2013, and just over two times its forecast cash flow.

It does not need to come back to the market it is good times for Sundance Energy shareholders.

undertheradarreport.com.au is a fortnightly newsletter focused on opportunities in small caps and is edited by Richard Hemming.

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